Saturday, September 13, 2008

Small-Format Food Retailing Memo: Not Technically 'Small-Format' But Whole Foods Market, Inc. is Going 'Smaller'

Small-Format Food Retailing Special Report

Amid a sluggish economy and slowing sales growth, Whole Foods Market Inc. is scaling down the size of new stores as the company finds massive grocery stores in most markets can't be justified.

The Austin, Texas, natural and organic grocer now plans to target new stores sized between 35,000 -to- 50,000 square feet, more than 20% smaller than what the company identified a year ago as its "sweet spot" amid successes with some large locations. The company is also renegotiating leases at several stores for smaller spaces than originally signed.

The size reduction by Whole Foods doesn't now make it a charter member of what we've coined as the small-format food retailing revolution going on in the USA. Instead it puts Whole Foods' stores right about in the middle in terms of the current average size of new supermarkets being built in the U.S.

For example, supermarket chains such as Safeway Stores, SuperValu, Inc., Kroger and most others are building new supermarkets that average about 45,000 -to- 60,000 square feet on the one end. Others such as regional players Wegmans (eastern U.S.) and HEB (Texas) have been building mega-supermarkets of about 100,000 square feet, at the other end. Then you have the small-format stores from Tesco (Fresh & Easy), Safeway (The Market) and Wal-Mart's soon to open Marketside, all which average from 10,000 -to- 20,000 square feet.

At its new "sweet spot" of 35,000 -to- 50,000 square foot stores, Whole Foods actually returns to its roots of the 1990's, when that was the size stores the natural grocer was focusing on. In the late 1990's to the present, Whole Foods went mega, opening numerous stores in the 70,000 -to- nearly 80,000 square foot range.

Smaller stores come with a host of lower fixed costs for rents and utilities, and also require fewer employees to run. That can help bolster key profitability metrics like sales-per-square-foot and sales-per-employee and improve the company's return on invested capital.

The smaller format was on display last week when Whole Foods opened its latest location in Richmond, Va. With 45,000 square feet of selling space, the store is smaller than most new ones open in recent years. But the store has mostly the same merchandise as larger stores, which should equate to comparable sales at lower costs.

It was also without any sit-down eateries that have driven up development and operating costs at some other stores. A Whole Foods in Fairfax, Va., for example, has four in-house restaurants including a barbecue joint called the Smokehouse.

The smaller Richmond store, meanwhile, has barbecue dishes available for self- service in addition to a hot food and salad bar, brick-oven pizza and a wine bar and cafe.

The moves for smaller locations come as Whole Foods is exhibiting signs that even the wealthiest consumers are cutting back on their consumption. Same-store sales rose just 2.6% at Whole Foods locations open at least a year, a far cry from the double-digit gains the food retailer enjoyed just a few years back.

Strong sales growth led to seemingly unmitigated growth by the chain, and store sizes followed suit. In 2005, Whole Foods opened its largest location, an 80,000-square-foot store in its Austin backyard that the company calls " enormously successful," and started to steadily increase the size of new locations.

But those larger format stores failed to live up to the performance of its Austin location and those in other dense, urban environments like New York. "

To be sure, Whole Foods, whose 270 stores average roughly 35,500 square feet, has continued to sign leases and open locations similar to its traditional layout and size. But the consumer spending slump has caused the company to rethink its development strategy, and retrench to store sizes from the past.

"With hindsight, reflection and some data points in front of us, we see that the really large stores are very powerful in limited markets and circumstances, and that smaller stores can also produce great returns for us," Chief Executive John Mackey said in an earnings call with food retailing analysts and media last month.

The real estate strategy is one of several moves Whole Foods is using to get back on track after its shares have lost more than half their value this year. The company has recently tried to emphasize value by offering more discounts and incorporating a value message into its marketing.

It is also planning on cutting back on new stores altogether, lowering its fiscal 2009 target to 15 new stores, down from a prior estimate of 25 to 30, as we reported previously.

Whole Foods also recently fired 42 headquarters employees as a cost savings measure.

As we've reported previously in Natural~Specialty Foods Memo, Whole Foods has had plans to open the first of its small-format Whole Foods Express concept stores in a former Wild Oats natural foods store building in Boulder, Colorado.

Initial plans called for that first Whole Foods Express store--which is designed to average 15,000 -to- 20,000 square feet and offer a limited assortment of natural and organic grocery items and feature fresh foods, such as produce and ready-to-eat and ready-to-heat prepared foods--to open this fall. However, as we previously reported, Whole Foods has been unable to agree on a new lease with the building's landlord at the Boulder site, which currently is still being operated as a Wild Oats banner store, so it has yet to start converting the building into the Whole Foods Express prototype store.

In fact, Natural~Specialty Foods Memo has now learned the Whole Foods Express concept is under review, as nearly everything at Whole Foods is, because of the supernatural grocer's significant drop in profits in the last quarter, which has resulted in the new strategies discussed in this piece, along with others.

Building and operating smaller stores isn't anything new for Whole Foods. In fact one of the chain's best-performing stores from a sales per-square-foot perspective is it 14,000 square foot store at 414 Miller Avenue in Mill Valley, in Marin County in the San Francisco Bay Area. That store averages between $500,000 -to-$600,000 a week in gross sales, according to sources in a position to know.

The Mill Valley store is where Whole Foods' co-president Walter Robb got his start. He opened the store in the early 1990's as the store manager, using his success with the Mill Valley store to move on to President of the Northern California Division and then eventually into his current position.

Additionally, the majority of the stores Wild Oats stores Whole Foods acquired in the merger last year are no bigger than 35,000 square feet, many being much smaller than that.

Whole Foods currently has plans to build some new stores even smaller than its new "sweet spot" size of between 35,000 -to- 50,000 square feet. These include two stores in San Francisco, one in the city's Noe Valley neighborhood and the other in the famous Haight-Ashbury district. Both of these stores are in the 17,000 -to- 20,000 square foot range. Another new store in development in Capitola, which is in Northern California's coastal region, also is smaller than 30,000 square feet.

We generally define a small-format food store as from 10,000 -to- 20,000 square feet in size, as do most others. The two San Francisco Whole Foods stores in development listed above fit that small-format definition. The Capitola store comes very close.

These however aren't specifically designed small-format stores like the Whole Foods Express prototype is. Therefore, it's our analysis that Whole Foods should move forward with its Express format.

If it can't open the first store in Boulder because of the lease problems that's fine. There still are numerous places where it makes even better sense to open one of the stores, particularly in an urban location where such a store makes much more sense for Whole Foods than it does to do so in Boulder, where the decision to do so was based largely on the fact that after acquiring Boulder-based Wild Oats, Whole Foods found itself overstored in the city of Boulder.

However, it pledged not to close any of the stores in the city that was home to Wild Oats. Therefore the natural grocer decided to turn one of the former Wild Oats stores into the Whole Foods Express as a way to differentiate the Whole Foods brand in the now overstored city.

We suggest opening a Whole Foods Express store in San Francisco or New York as a first test. It makes good sense to do from numerous perspectives, including geography, density, cost, maximization of sales per-square-feet, and more.

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